Friday April 26, 2024
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5.3.1 Excess Business Holdings
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Excess Business Holdings
Excess Business Holding Tax If a private foundation or CRT violates the excess business holdings rules, there is a tax of 10% of the value of the excess business holdings.
Excess Business Holding Definition The excess business holding is defined under two negative standards.
Key Excess Business Holding Percentages There are three major percentages that apply to excess business holdings.
A Disqualified Person: A disqualified person is the donor to a unitrust or the major donor to a private foundation, a private foundation manager, or an owner of 20% of the business entity that is a donor.
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Competition between for-profits and nonprofits is a continual area of contention. For-profits are concerned that nonprofits compete by providing similar goods and services and yet are exempt from federal income taxes. For public charities, the unrelated business income rules of Secs. 511-514 limit the ability of charities to compete unfairly with the for-profit businesses. For private foundations and charitable remainder trusts (CRT), the Excess Business Holdings rules of Sec. 4943 serve the same purpose.
Excess Business Holding Tax
If a private foundation or CRT violates the excess business holdings rules, there is a tax of 10% of the value of the excess business holdings. If this excess business holding amount is not transferred prior to the last day of the taxable year, the tax amount may be increased to 200% of the excess business holdings. Sec. 4943(b).
Excess Business Holding Definition
The excess business holding is defined under two negative standards. First, the excess business holding rules do not apply to entities that receive 95% or more passive income. Sec. 4943(d)(3). In PLR 200450036, the Service permitted a contribution of partnership assets to a private foundation. However, over 95% of the return on the partnership assets was passive income. Therefore, the exception for passive income applied.
In addition, there also is an exception in Sec. 4943(c)(3) for a business that is "functionally related" to the exempt purpose of the charity. Therefore, if a charity is operating a related business that is clearly part of its exempt function, that is permitted.
The result of these two exclusions is to include nearly all active businesses. If a private foundation or CRT owns an active business with more than 5% active income, which is not a particularly high standard, and it is not directly related to the exempt purpose, then the excess business holding rules apply.
Key Excess Business Holding Percentages
There are three major percentages that apply to excess business holdings. First, if the donor to the private foundation or CRT, who is a disqualified person under Sec. 4946(a) owns 20% or more of the stock or interests in the business, then excess business holding rules apply. There are two additional qualifications. If it can be shown that a third person has effective control of the enterprise, then the donor may own up to 35%. Sec. 4943(c)(2)(B).
Finally, there is a 2% de minimus rule. If the private foundation or CRT owns 2% or less of the stock or interest in any enterprise, then the excess business holding rules do not apply.
A Disqualified Person
A disqualified person is the donor to a unitrust or the major donor to a private foundation, a private foundation manager, or an owner of 20% of the business entity that is a substantial donor. If the donor controls the trust, partnership or corporation with more than 35% interest, then that entity is also disqualified. In addition, lineal decedents and lineal ancestors and their spouses are also disqualified persons. Sec. 4946(d).
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Private Letter Rulings
PLR
200444042 Foundation May Create Holding Company to Manage Its Investments:
PF is a private foundation, and it finances its charitable activities from the returns on its investments. Recently, PF and other private foundations acquired stock in Holding Company. PF and the other private foundations formed Holding Company for the sole purpose of making and holding an investment in LLC. LLC manages investment funds as limited partnerships, trusts and limited liability companies.
PLR
200450036 Gift of "Passive" Partnership Interest Avoids Excess Business Holdings:
Bill and Cathy Donor created Private Foundation (PF). Bill and Cathy serve as directors of PF, however, they receive no compensation. Bill and Cathy were the sole contributors to PF and wanted to make a unique contribution to PF. In particular, they wanted to give partnership interests to PF. At present, the partnerships both receive mostly passive income, i.e., interest income, rental income and capital gain income.
PLR
201603032 Foundation's LLC Not Excess Business Holdings:
A private foundation (Foundation) operates affordable housing for lower income and elderly persons who need assistance. Foundation is a managing member of LLC, which operates a low-income housing project (Project).
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